11/17/2020 11:00:00 PM
Market Update (18/11/20)
Welcome to the November market update.
In our latest video, we were joined by Kiwibank Chief Economist Jarrod Kerr, and covered off these questions:
- How low are interest rates going to go?
- Are house prices going to keep going up?
- Is there a risk of an asset bubble in house prices?
- What's been happening in the markets in the last couple of weeks?
- How has news of a Covid-19 vaccine impacted Pie's approach?
We have also included a transcript.
Founder and CEO
Sam De Court: Hi everyone, my name’s Sam De Court, and with me I have Pie Funds founder and CEO Mike Taylor, and Australasian Portfolio Manager Chris Bainbridge.
So Mike, Chris and I are up in the Takapuna office. It’s spectacular summer-like conditions outside. It's Friday afternoon, I think there might even possibly be a swim on the agenda this afternoon down the beach. What's the conditions like down in Hawke's Bay where you are?
Mike Taylor: That's a big call to go for a swim in October, I hope you’ve got a wetsuit.
SDC: So Mike we'll start with you this week. So what's been happening in markets?
MT: Since we last caught up Sam on this forum, markets have been quite mixed actually.
They had a good run into the beginning of September. And there was quite a sharp correction in tech stocks following that, and since then it's been pretty mixed. We've seen delays to stimulus packages in the EU, and in the US, which of course marks a bit of concern. We've obviously had some worries about the election. But then, somewhat concerningly, we have seen a continuing escalation in Covid-19 cases in Europe again so European cases are back up on the rise and there’s partial lockdowns coming into many European countries again. So, that’s a bit of a cause of concern. So with those kind of Covid-19 cases on the rise, it has meant that some of the Covid-19 beneficiary stocks, once again, leading the charge and have been doing quite well the last couple of weeks. So that’s a bit of a roundup, since we last spoke.
SDC: Thanks, Mike. So Chris, you are obviously portfolio manager of the Australasian Growth 2 fund which has had a really great run this year. And I think before I get into your question it's probably an important reminder to clients, given the sort of unprecedented events of 2020, returns have been particularly strong and, arguably, a little bit unique. So I think it’s probably an important reminder that when you've experienced these sort of returns, it's a good idea to set expectations a lot lower for certainly the year, or even years, ahead. So Chris, the question I've got for you is, how have you been able to generate so much outperformance with the Growth 2 Fund this year.
Chris Bainbridge: I think in the context of returns starting off, you’ve absolutely nailed it. It's a really important point. Performance doesn't come in a straight line and, you know, investors should probably moderate your expectations going forward. But coming to your question, I'd like to come up with something sexy Sam, but it really just boils down to process. And in particular, two points, concentration and conviction. Growth 2’s trading strategy, meaning that it holds only around 20 companies, that's relatively unique because most managers out there hold between 40 and 60, and concentration proved critical during COVID. Let me explain why. Our job as investors is to underwrite the future. Winners going into a crisis generally aren't the winners coming out of it. And this proved to be the case with Covid-19. Covid-19 accelerated the future. We all started shopping online, using meal-kit delivery and working from home. When you only have 20 companies in the fund, instead of say 50, you have less decisions to make. Less decisions means more time, and more time allows to identify and invest in a number of emerging winners.
The second point is conviction. We're a high conviction fund manager. Conviction means that we take large positions, when the odds are in our favour. For example, 40% of the portfolio is generally held in the top five positions. Luckily, a number of those large positions have exceeded expectations this year, contributing to performance. Now, let's be clear, I made many mistakes during Covid-19. For example, I sold Afterpay at $11 and had to buy it back in the 20s, and probably my biggest mistake was not embracing change enough. But I guess to sort of summarise the answer to your question is that performance has come down to concentration and conviction. These have been pillars of Pie’s investment process since the beginning and you know they’ll be pillars going forward.
SDC: Thanks Chris. You'd probably agree that if you want higher returns it’s going to be a bumpier ride to get there. What are you doing to protect the downside, whilst also positioning the fund for future growth?
CB: Yes. It's a great question. I'll answer it directly in a moment but I think it'd be useful to frame how we think about risk, generally, and particularly in the context of loss aversion. So loss aversion refers to the fact that people feel loss twice as much as they feel gain. Now this genetic aversion to risk taking was useful 10,000 years ago, when pretty much everything out there could eat us or kill us. However, it's less helpful when investing. Investment managers feel loss aversion just like every other person. This leads many managers to take smaller, more predictable risks, rather than larger less predictable ones. We believe that this is harmful to long term returns, and we won't shy away from making investments, which others perceive to be higher risk, where we believe that the potential payoffs are worthwhile. I guess to kind of simplify it Sam, what I’d say is that investors should consider Growth 2 to be more like a speedboat, rather than a car ferry. The ride may be a bit bumpier, but our objective is to get you to your destination faster.
Turning to your specific question, how do we manage risk? The best way to manage risk in theportfolio is at a company level, and that's by investing in quality companies. Quality means investing in companies with four Ps: Product, Potential, Predictability and People. In terms of product, we want a unique product. In terms of potential, we want that product to be sold in a large addressable market, particularly a global market. And then in terms of those two we want predictability and predictability means that we want recurring revenue streams or a predictable formula for forecasting revenue in the future. Finally, and most importantly, we want people, the right people. That means entrepreneurial managers, preferably founders, with significant skin in the game. You know, we generally talk about the importance of founders but I guess just a couple of words on that. Founders create optionality that professional managers don't. They generally do that because they're more secure in their tenure, and they feel that they can take, you know more sort of upside focus for risk, rather than say a professional manager might, that creates optionality which is which is difficult to price, but, you know, just because you can't price it doesn't mean to say that you shouldn't pay for it. Stepping back, to sum it up Sam, whether it's concentration, conviction or risk management, everything boils down to sticking to our process. And that’s a process that we're constantly challenging and evolving on a daily basis.
SDC: Thanks a lot, Chris, that's really interesting. So Mike back to you. Obviously some people may have noticed there is a bit of a US election just round the corner. My question for you is, what are the possible implications on markets? And how is Pie positioned going into the sort of November 3rd election date?
MT: So you don't think that our own election will move markets, Sam, globally?
SDC: Possibly not as much as the Americans.
MT: At the moment Biden has a nine-point lead, quite a convincing lead at this particular point in time. There are also, of course, a number of what they call swing states, where the race is a little bit closer, states like Ohio and Florida. People will remember as well from 2016, when we had the election where Hillary Clinton was in the lead at this particular point but she lost the election. She did win the popular vote. So there's a chance that Biden could win the popular vote but still lose the election because of the way the Electoral College system works in the States. However, according to most betting websites at this stage [16 October], Biden’s chance of victory is about 87%. So in order for him to actually lose, something would have to come out between now and 3rd November, to hamper his chances. I think actually, there was an FBI probe into Hillary Clinton's emails right before the election last time, and they reckon that was one of the reasons why she actually lost, so as at today [16 October] it looks like a Biden victory. The market is pricing a Biden victory. And the market seems comfortable with a Biden victory. In fact, there's a number of stocks which are what we might call kind of ‘blue beneficiaries’, which have done particularly well, and they kind of relate to the clean energy sector in the States. It’s expected that a Biden presidency will result in a substantial fiscal stimulus for clean infrastructure, which would generally be positive.
We'd also expect post election, a general US stimulus package to come and be approved as well, so markets are pretty comfortable at the moment. I even think if it did flip and Trump did win I think it'd still be happy. What would make markets unhappy would be uncertainty, and getting to the end of election and the election being disputed. Not knowing who's going to be in power, that's what will cause uncertainty. So really what markets focus on is uncertainty in the outcome, the stimulus package and consistently low rates from a supportive Fed. That's what really matters. So the actual outcome of who really wins probably not that important for investors, as long as they've got certainty.
SDC: Great, thank you very much Mike and thank you very much Chris, and thanks everyone for watching. We look forward to seeing you in a month.
Sam De Court: Hi everyone, my name is Sam De Court and thank you for tuning in today. With me today is Pie Funds founder and CEO Mike Taylor, and our special guest today is Kiwibank Chief Economist Jarrod Kerr. Good to see you again Jarrod and thanks a lot for starring in our video. So let's start with you. So plummeting interest rates is a topic that we're talking to our clients about it seems like every single day. And it seems most banks are now offering term deposit rates of under 1%. How low are interest rates going to go?
Jarrod Kerr: Well I don't know exactly how far but I can tell you they're going to continue to fall from here. The Reserve Bank had their monetary policy statement last week, and within that they did a few things. But the most important was a funding-for-lending programme for the banks, where they give banks access to cheap cash at the cash rate of just 25 basis points, and then tell us to go on and lend it. Now initially we can get 4% of our total loan book worth of funding. And then later on after 18 months, if we still need it, we can get an extra 2%. So over the next two years we can get 6% of our entire book, worth of this cheap funding, and that compares to, as you say, deposit rates which we fight hard for. Retail deposit rates are a bit under 1% now. The signal out of the central bank is, it's time to start ratcheting those rates lower. So deposit rates I think will fall, and therefore mortgage rates and business lending rates will fall as well. And I think most of the reaction will take place over the next three to four months.
SDC: Thanks Jarrod. So my personal mortgage rolls off in May next year, so that should be a good time?
JK: You have timed that beautifully.
SDC: So the next topic is housing prices. So we're hearing about this on the news every single day. We probably all know someone who's either missed out on an auction recently, or someone who's sold a house for way more than they expected. Are house prices going to keep going up?
JK: The short answer is yes. We have all been surprised at how resilient the housing market has been, and we're all surprised at just how far interest rates have gone and boosted the housing market. As you say, you put your money in the bank, you're getting less than a percent on it. So we're seeing quite a few savers actually look to go out the risk spectrum, and invest their money elsewhere. And one of the most obvious examples is putting that money into a dwelling with a rental yield of 3, 4, 5% in some regions, lock that away and they're happy. Otherwise, they're also going into equity markets and, you know, pushing money into, I guess, more aggressively-looked-after portfolios. And that's the whole point of monetary policy. The Reserve Bank is trying to lower interest rates to put cash in our back pocket for those who have debt, but they're also trying to do what they call the wealth effect and that is boost asset prices throughout the economy, so not just house prices but that's the main asset we seem to focus on, boost those prices so that people feel more confident they've got a bit more equity in their homes, and they then hopefully go out and invest or spend more later on. What we've seen in the housing market has been truly sensational. It really has been the bounce back that none of us expected. We were all forecasting house prices to decline, simply because we had an unemployment rate heading towards 8, 9, 10%. The unemployment rate doesn't look like it's going to go that far, and people really have shored up their confidence in the housing market and are piling money in. We've been filling our boots with loan applications over the last three months, and that looks like it'll continue into next year. The next thing to come in is the LVR restrictions. The LVR restrictions were taken off for a year. So they were supposed to come off in May next year. They're actually going to come off in March. So banks are preparing that now because we offer a 90-day pre approved loan so you'll see banks starting to tighten up their lending standards pretty much now. That'll take some of the steam I think out of the housing market next year, but geez the fundamentals are supportive. And the one issue that I don't think we talk about enough is the lack of supply. Why is that a house price can jump 20% in the last year. Well it's because there's not many options out there. We have a shortage of affordable dwellings. We've modelled that at about 80,000 dwellings which is quite a significant shortfall that's been built up over the last 10 years. It's going to take us years to unravel that, even though we are seeing a decent pickup in dwellings coming.
Mike Taylor: Does that pose a risk of an asset bubble in house prices?
JK: Absolutely. House prices can't keep going up 15, 20% a year. And this is the discussion which is coming through right now, and it's being put back onto the Reserve Bank. You know, your dual mandate that we all know and understand really well which is price stability of a CPI basket. And, you know, some sort of full employment measure, we get that, and it's going to take a long time to get those two mandates. But there's also a financial stability angle as well, and they look at that through the lens of what are the banks doing? Are they doing lending which could unravel in the future, and that's the high LVR stuff. There's just simply more risk associated with someone who puts less skin in the game, so that's why those LVR restrictions are coming back on. And I think, you know, dare I say it this time next year, had prices have gone up another 10, 15, 20% and then we'll see more action from the central bank.
SDC: Mike, we'll turn to equity markets now it feels a little bit like the last month has been a roller coaster. Can you maybe explain a little bit what's been happening in markets over the last couple of weeks?
MT: Yeah, it has been a bit of a roller coaster. In particular, there's been quite a big, or a savage, rotation in markets but let's sort of talk about what was the lead up to it. So we had a bit of a sell off in the markets in the lead up to the US election. And so that was really due to uncertainty and people trying to take some risk off and be positioned for an outcome which might be difficult to decide. Then the election result came out, and it was sort of a worst case scenario for markets. But for some reason, they seemed to take confidence in the fact that at least the result had been concluded. Most people agreed that Trump has lost and Biden had been successful. It's also a little bit of a Goldilocks scenario is they get a president who will be conciliatory towards China and Europe and trade, but they will be able to keep in place the tax cuts that were put through by the Republicans. And on top of that it's one of the pointers that Biden's massive green energy infrastructure plan, which was potentially a little bit inflationary, won't get pushed through too so markets seem to be quite happy with a Biden president, that's sort of kept in check by the Republicans, if you could say that. So as a consequence markets have gone up.
MT: In addition to that, we've had first results out on the vaccine which was by Pfizer. And I think that the level of efficacy was much higher than they thought, at a 90% success rate. So, markets were quite enthusiastic about that. And that pushes what we call the rotation trade. So everyone had been buying tech stocks in the belief that we'd be working at home forever, and dumping travel, banks, airlines. That trade flipped in a day. And we saw some very violent moves where some tech stocks that had rallied hard dropped 20%, and the travel ones were up 30 or 40% in a day. So that actually meant in some cases that markets stayed flat, or did rise a little bit, but actually underlying that there was a lot of churning. As that churning's kind of faded out at the moment, by the time we've recorded this video, but I expect there's still further to come on that, because I would expect more vaccine news before Christmas. And of course, the level of Covid-19-related hospitalisations and deaths in the US is not great. I think today it's up 177,000 recorded cases in the last 24 hours which is a new record.
SDC: So Mike, on that point about the vaccination. How has this news and this development in the last kind of week or so, how has it impacted Pie's approach? What changes is the investment team doing and how is it changed the outlook?
MT: So, what we did straight away is looked through the portfolios to see what exposure we had to cyclicals and recovery type plays. We had a few more of them in the portfolio but actually, some of them had performed poorly. So we exited them, it might be a bit early on that play. So now we are starting to add a few companies that we think will benefit from a sort of cyclical upswing, possibly in the second half of 2021. That's where the markets seem to be looking forward. However, we haven't dumped tech all together. And the reason for that is that some of the trends that have been put in place because of Covid-19 are permanent. And in addition to that, if you think about most of the Northern Hemisphere, they are in winter now, Covid-19 is rampant, many places are locked down so those online companies will do very well this Christmas. If you think of companies like Etsy or Netflix, Disney, things like that. They should have really good numbers this year.
SDC: Thank you very much Mike and thank you very much Jarrod for being our special guest. Thanks everyone for watching, and we'll see you next month.
To download our product disclosure statements, go to www.piefunds.co.nz. Past performance is not an indicator for future returns. This information is general in nature only. You may wish to discuss with an expert before relying on it.